There’s good news on the retirement-investing front: Younger workers are taking things more seriously than their predecessors did. They’re investing in workplace plans like 401(k)s sooner, putting more aside and prizing growth over excessive safety.
But is it good enough? Many experts feel that young workers, likely to change jobs more often than their parents did and unlikely to have a traditional pension, still need to take it up a few notches, mainly by putting more aside and boning up on investing skills. Recent trends like automatic enrollment in workplace retirement plans help assure that young people start preparing for retirement, but don’t make participants into savvy investors by themselves.
“The old adage about leading a horse to water is certainly true,” says Andrew Meadows, vice president at Ubiquity Retirement + Savings in San Francisco. “Studies certainly show that auto-enrollment increases participation in a 401(k), but it doesn’t necessarily mean it increases engagement. I always feel that folks should take a more active role.”
A recent study by the Investment Company Institute, the fund-industry association, found that the median age at which millennials bought their first mutual fund was 23, compared to 26 for Generation X and 32 to 37 for baby boomers.
Part of this, of course, is due to the growing availability of mutual funds, which weren’t a major investing option when the first boomers came of age. The financial crisis and Great Recession also undoubtedly rammed home a lesson about preparing for life’s curveballs.
But an especially important factor for millennials is investing options through workplace defined contribution plans, such as 401(k)s and 403(b)s. The ICI study indicates that 67 percent of households that bought their first mutual fund in 2010 or later made the purchase through an employer-sponsored retirement plan, compared with 57 percent who used employer plans to buy their first mutual fund before 1990.
More recently, companies are increasingly enrolling new employees automatically, rather than simply giving them an option to participate. Employees can still opt out, but experience shows many will take the path of least resistance and stay in.
And defined contribution plans are more often using target-date funds as the default investment in auto-enrollment. These use a mix of stocks, bonds and cash considered suitable given the employee’s age, with most of the assets kept in stock mutual funds for a young worker, and more shifted to safer holdings like bonds as the employee gets older. Target-date funds have thus countered employees’ well-documented tendency to be overly cautious, missing out on the better gains typically provided by stocks over the long term.
Median millennial stock allocation is now an admirable 89 percent, according to Vanguard Group, the mutual fund giant. “Automatic plan design features and the rise of target-date funds are reshaping retirement plan outcomes for all generations,” writes Jean Young, research analyst with Vanguard Center for Retirement Research, in a report on a study of millennial investing behavior.
Although the numbers are improving, they are far from good enough. In 2013, millennials set aside just 3.6 percent of their pay for defined contributions in voluntary enrollment plans, and 4.2 percent in automatic enrollment plans, Vanguard says. While that’s up from the 3.1 percent for the same age group in 2003, it is far below the 10 percent many advisors consider a minimum. The law allows people younger than 50 to contribute up to $18,000 a year, while investors 50 and older can contribute $24,000.
So what should the young investor do? Experts make five key points about direct contribution investing:
Invest as much as you possibly can. “After you get comfortable, in future years start working your way up to the $18,000 annual maximum deferral,” says Matt Armstrong, a financial advisor with Savant Capital Management in Rockford, Illinois. A $1,000 contribution at age 25 could grow to $21,725 by age 65, assuming returns average 8 percent a year. Delay that contribution to 35, and it will grow to just $10,063.
Get your employer’s matching contribution. Many employers will match the employee’s contribution, often giving 50 cents on the dollar up to some limit, such as 6 percent of pay. “It’s free money! No skill needed to check this box,” Armstrong says.
Don’t assume the default investment is best. “By and large, default options can generally be effective in guiding younger participants during the early phases of accumulation within their [defined contribution],” says Michael Doshier, vice president of Retirement Marketing at Franklin Templeton Investments in Rancho Cordova, California.
But he says that some employers use an overly simplistic process for selecting the defaults, so the automatic option may not really be the best choice. Most defined contribution plans have other options as well.
Also, he adds, fine-tuning the holdings is often needed to match investments to individual situations as the investor ages. “One-size-fits-all options are not as popular with participants approaching retirement, who tend to take on a more active role in managing their portfolio to meet their particular needs,” he says.
So the young plan participant is wise to start studying investment topics like diversification and returns versus risks. Life events like a job change, marriage, divorce or having children might dictate a new investment strategy.
“I believe a simple solution [such as a] target-date fund is a good starting point for the employee with a smaller balance,” says Bob Burger, founder of Disciplined Money in Phoenix. “Once the employee’s balance passes $50,000, I start to consider whether we should look at taking a more active approach to the allocation.” That often entails complementing holdings with investments in IRAs and taxable accounts that offer more investing options, he says.
Emphasize stocks. Although stocks are riskier than bonds and cash in the short term, young investors have time to ride out the downturns and enjoy the larger returns stocks have historically provided over the long term.
“Younger investors typically would skew their holdings to riskier assets [like stocks],” says Bill DeShurko, president of 401 Advisor, a registered investment advisor in Centerville, Ohio. In fact, he suggests that young investors have a healthy dose of small-company stocks, which are especially risky but have done well over long periods.
Consider an IRA rollover. After leaving a job, you have the option of shifting your assets into an IRA. “IRAs generally offer significantly more investment options,” says Simon Hamilton, head of the portfolio manager department at Wise Investor Group in Reston, Virginia. A rollover can help eliminate investing overlaps if you have plans from more than one employer, he says, and it may make it easier to use more sophisticated strategies like naming multiple beneficiaries.
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